On Friday, PTGi Holding, Inc. (now ticker HCHC, but formerly PTGI) filed with the SEC to change its name to "HC2 Holdings" (which we think informally stands for Harbinger Capital 2, although that is not the legal name) and change its ticker to HCHC. This will be effective as soon as tomorrow (4/13/14). To get to the point, we think HCHC will acquire the assets of Falcone's liquidating hedge fund, Harbinger Capital Partners LLC (NYSE:HCP), allowing the hedge fund to liquidate in an orderly and timely manner, while enabling Falcone to retain an interest in assets of the fund which he would not have wanted to sell if not for the SEC settlement. It is unclear at this point what a transaction will look like or when it will be announced (as soon as tomorrow?), but there are several financing options available, including the rights offering we previously described, capital from publicly traded Harbinger Group (NYSE:HRG), as well as capital from players such as Fortress and Leucadia that have previously invested in HRG (Leucadia, Fortress) and other Falcone backed assets such as spectrum company LightSquared (Fortress).
In the recent write-up, I highlighted the tangible book value of PTGI assets, the value of the NOL, and the implications of a possible rights offering transaction. Since then the 10-K has been released and shows a lower tangible book value (in line with our asset "haircut" scenario) and a slight decline in the NOL position. However, the blatant signal of the selected name change, as well as disclosures in the 10-K clearly telegraphing a deal-making relationship with Harbinger Group (abbreviated "HGI" in the 10-K), of which Falcone is CEO and Chairman, suggest that we should, at this moment in time, divert our focus from what the current value of PTGI is, and focus more on the potential for value creation through the type of transaction HC2 appears to be on the cusp of pursuing.
When the SEC barred Falcone from the securities industry for at least 5 years, and fined him and Harbinger $18M, they allowed him to continue running HRG as well as privately held LightSquared Inc. The SEC did not bar him from serving as a director because they believed forcing him to admit wrongdoing was likely to serve as a warning to potential investors in his companies. Falcone was also permitted to assist in the liquidation of HCP.
Without question, Falcone's behavior in HCP was appalling, but we think that with the SEC having made an example of him by forcing him to admit wrongdoing, something that had been an unusual step until that point, he will not be so bold in the future. Moreover, we think the investment opportunity at hand is worth the potential risk of getting involved in HC2. Great investments often have this kind of "hair" on them, creating the necessary conditions for outsized returns through emotionally rather than probabilistically driven aversion, for investors willing to underwrite the risk.
A couple of prominent assets in HCP include LightSquared (which Charlie Ergen thinks is worth as much as $8.9B if it gains regulatory approval, including the present value of a $2B NOL position), as well as Asian Coast Development (Canada) Ltd, a Vietnamese casino resort. There are others, and the positions must be liquidated. The various positions and ownership stakes represent Falcone's best ideas, having been previously placed in the lucrative pay-for-performance compensation structure of a hedge fund vehicle. The best possible arrangement is for these assets to be sold to HC2 so that HCP limited partners can elect to move on to new opportunities and Falcone can retain an interest in the assets. Why do I use the word "elect", as if LPs have a choice of whether to receive distributions or not? One possibility is that LPs, rather than receiving cash, will be paid in shares of PTGI, allowing them to retain upside in the assets, if they so choose. While this distribution could result in selling pressure for LPs that elect to convert their shares to cash, PTGI has previously been extremely illiquid, and with HCHC likely to list on an exchange in conjunction with this transaction, the selling will allow savvy investors to finally build a position with better access to liquidity. Alternatively, the shares may be registered slowly, over time to allow shares in HCHC to develop a more liquid market before LPs can sell so that they capture higher value for their share sales.
What financing options are available to purchase HCP's assets? A rights offering as we previously described is one option. Another is the issuance of HC2 stock in exchange for all or certain assets of HCP. A third is that one of the previously mentioned financing candidates could provide a convertible note to HC2, and HCP LPs would receive a combination of stock and cash. Whatever path is pursued must be approved by the SEC, which is monitoring the HCP liquidation.
It's impossible to say at this point exactly what kind of transaction we might see. However, we have laid out some likely options. Falcone appears to be using HC2 as his next deal vehicle. With the right kind of deal making and investing savvy, we expect a long runway of value creation.
Disclosure: I am long PTGI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Armored Wolf, LLC holds shares in HCHC on behalf of its various client accounts. In addition, the author holds shares of HCHC in his personal accounts.